Small Turns Big in China’s Stock Market as ChiNext Values Surge

Small Turns Big in China’s Stock Market as ChiNext Values Surge

Companies in China’s benchmark index for small-capitalization stocks have never been so big.

The ChiNext Index has surged 80 percent in the past 12 months, lifting the median market value of its components to a record $1.1 billion on Jan. 15. That’s the highest ever relative to the nation’s benchmark Shanghai Composite Index (SHCOMP), which has a median value of $784 million, and the biggest among small-cap measures in the world’s 10 largest equity markets. Gauges for small companies in Brazil, Russia and India have dropped at least 10 percent during the same period.President Xi Jinping is seeking to boost the technology and services industries, which comprise about half of the ChiNext’s weighting, and curb the role of state-owned companies as growth in the world’s most-populous nation slows. While UBS AG says ChiNext valuations may fall as a flood of new share sales diverts funds, Bocom International Holdings Co. and Dragon Life Insurance Co. predict a further rally as earnings increase and the government encourages ownership of small companies.

“The ChiNext reflects the part of the economy that has better growth opportunities,” said Richard Gao, a San Francisco-based money manager at Matthews International Capital Management LLC, which oversees about $26 billion. “We are seeing more and more opportunities in the non-state-owned private sector, such as information technology, consumer and health-care industries.”

Funds Buy

Money managers in China have increased positions in smaller companies to about 33 percent of holdings, a six-month high, while allocations to large-caps have fallen to 25 percent, according to Hao Hong, chief China strategist at Bocom International, who cited Wind data. The ChiNext may jump as much as 29 percent this year as earnings grow at a 20 percent pace and more funds purchase the shares, Hong said.

“Once you see your peers buying small caps that are outperforming, there is pressure to match up,” he said in a phone interview from Hong Kong. Trading in China’s domestic stock markets is dominated by local institutions, individuals and companies while access for overseas money managers is limited by the Qualified Foreign Institutional Investors program.

The ChiNext was created in 2009 as an alternative for smaller companies seeking to raise funds and has fewer listing requirements than the two main boards in Shanghai and Shenzhen. The CSI 300 Index, the benchmark gauge for China’s larger companies with a median value of $3.7 billion, has retreated 14 percent during the past 12 months. The Shanghai Composite dropped 12 percent.

Valuation Surge

Leshi Internet (300104) Information & Technology (Beijing) Co., the biggest company in the ChiNext index with a market value of 37.4 billion yuan ($6.2 billion), has surged 326 percent in the past 12 months. The provider of Internet videos and maker of smart TVs is valued at 194 times reported earnings, up from about 45 times a year ago. The company will probably boost earnings by 52 percent in 2014 after last year’s estimated 44 percent increase, according to the average of 10 analysts’ estimates compiled by Bloomberg.

Huayi Brothers Media Corp. (300027), the second-largest ChiNext company, has jumped 283 percent. Huayi’s movie, “Journey to the West: Conquering the Demons,” generated 1.25 billion yuan of revenue last year, the most among domestic films, the China Daily reported Jan. 8. The stock trades at 68 times reported earnings, versus a three-year average of 50 times, data compiled by Bloomberg show.

IPO Concern

The surge in valuations is probably unsustainable, according to Chen Li, the chief China equity strategist at UBS in Shanghai. The ChiNext, which slipped 1.4 percent yesterday, trades for 6.1 times net assets. That compares with a multiple of 1.3 for the Shanghai Composite. The Russell 2000 Index, a benchmark gauge of smaller U.S. companies with a median market value of $726 million, trades at about 2.6 times net assets.

A flood of new share sales may weigh on ChiNext companies as investors sell existing holdings to subscribe to China’s first initial public offerings in more than a year, according to Chen, who predicted in May that the “bubble” in small-cap stocks would burst within two months.

The securities regulator has approved 52 companies for IPO sales, according to data compiled by Bloomberg. Companies may raise 250 billion yuan this year, PricewaterhouseCoopers LLP said this month.

The increase in supply of shares will “pose a big challenge to the valuation of ChiNext companies,” Chen said at a briefing in Shanghai on Jan. 13.

Wrist Cutting

Government policies are providing support to the stocks. China started allowing insurers to invest in ChiNext companies on Jan. 7, while the Shenzhen exchange said on Dec. 13 that investors must have existing stock holdings before participating in IPOs.

“I don’t see the rally for small caps tapering,” Wu Kan, a money manager at Dragon Life Insurance in Shanghai, which oversees about $3.3 billion.

Premier Li Keqiang has signaled he will tolerate slower growth to shift the economy away from the state-led stimulus that sparked the 2009 recovery, to a more sustainable model based on services and consumer demand.

Transforming the economy is a “self-imposed revolution” that will “feel like cutting one’s own wrist,” Li said at a press conference last March. China’s gross domestic product probably grew 7.6 percent in 2013, the State Council said last month. That would tie 1999’s pace as the lowest since 1990 and be just above the 7.5 percent growth goal for the year. Analysts surveyed by Bloomberg News last month see a 7.4 percent expansion in 2014.

Tech Support

In November, China’s leaders said they would allow markets to play a greater role in allocating resources and encourage private investment in more industries as part of the the biggest expansion of economic freedoms since at least the 1990s. China’s central bank said it supports the development of technology companies and will allow the formation of smaller lenders to support the businesses, according to a statement on the monetary authority’s website Jan. 15.

The ChiNext index has a 29 percent weighting in technology stocks, while health-care companies comprise 21 percent of the gauge and consumer shares account for about 16 percent. Those three groups combined make up about 19 percent of the Shanghai Composite, data compiled by Bloomberg show.

“We are seeing a big change in market capitalization,” said Cao Jin, a fund manager at HSBC Jintrust Fund Management Co. in Shanghai. “This is inevitable given the change in the nation’s economic structure.”

To contact Bloomberg News staff for this story: Zhang Shidong in Shanghai at; Allen Wan in Shanghai at; Weiyi Lim in Singapore at

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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